Professional Documents
Culture Documents
PUBLISH
OCT 31 1997
PATRICK FISHER
TENTH CIRCUIT
Clerk
HARV L. JEPPSEN,
v.
Petitioner-Appellant,
COMMISSIONER OF INTERNAL
REVENUE,
No. 96-9002
Respondent-Appellee.
Appeal from the United States Tax Court
(T.C. No. 26718-92)
Bill Thomas Peters, Parsons, Davies, Kinghorn & Peters, Salt Lake City, Utah, for
Petitioner-Appellant.
Sarah K. Knutson, United States Department of Justice, Washington, DC
(Teresa E. McLaughlin, United States Department of Justice, Washington, DC,
with her on the brief), for Respondent-Appellee.
Before EBEL, Circuit Judge, McWILLIAMS, Senior Circuit Judge, and
KELLY, Circuit Judge.
EBEL, Circuit Judge.
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T.C.M. (CCH) 199, 199, T.C.M. (P-H) 95,342 (1995), T.C. Mem. No. 1995-342.
At that time, Jeppsen had no prior experience investing in stocks or stock options.
Barker, who knew that Jeppsen was not experienced or sophisticated in
securities investments, fraudulently established Jeppsen's E.F. Hutton account as a
discretionary account in order to authorize Barker to transact securities trades in
the account. Shortly thereafter, Barker began to churn Jeppsens investments
by purchasing and selling various call options.
In September, 1986, Barker left E.F. Hutton and began working at the
brokerage securities firm of Piper, Jaffray and Hopwood, Inc. (PJ & H). In
December, 1986, Jeppsen transferred his E.F. Hutton account to PJ & H so that
Barker could continue to act as his broker. At that time, Barker fraudulently
obtained Jeppsens signature on documents needed to open a PJ & H margin
account in Jeppsens name. In addition, without Jeppsens permission and
without ever obtaining Jeppsens signature, Barker established Jeppsens primary
PJ & H account as a discretionary account. Barker then invested much of the
money in this account in certain penny stocks whose price was manipulated by
Barker and an accomplice through repeated purchases and sales.
In July, 1987, Jeppsen became aware of Barkers activities, and ordered
Barker to close his margin account immediately. Barker failed to close the
account. When Jeppsen received his next monthly statement indicating that the
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margin account had not been closed, Jeppsen again ordered Barker to close the
margin account. Barker again failed to close the account, and continued to
execute new transactions in the account.
On October 7, 1987, Jeppsen specifically instructed Barker to immediately
liquidate to cash the entire balance of Jeppsens PJ & H account, except for a
mutual fund. Barker did so slowly, forging Jeppsens signature when necessary to
liquidate certain high-risk derivative investments that Jeppsen had never
authorized him to make.
On October 19, 1987, a date popularly known as Black Monday, the Dow
Jones Industrial Average decreased in value by 22.6 percent. As a result,
Jeppsens PJ & H account, which had not yet been liquidated, declined in value
by approximately $194,000.
The following week, Jeppsen met with PJ & Hs branch manager and
Barkers supervisor, Don Larkin, to discuss the losses Jeppsen had suffered in his
PJ & H account. Larkin initially told Jeppsen that because of the large negative
balance in Jeppsens margin account all securities in his discretionary account
would have to be sold to pay Jeppsens debt to PJ & H. When Jeppsen protested
that the trading losses had been caused by Barkers unauthorized activities in
Jeppsens name, Larkin admitted to Jeppsen that Barkers activities had been
improper. Larkin then formally reprimanded Barker for the unauthorized
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Jeppsen claimed a theft loss deduction in the amount of $166,627 relating to the
losses he incurred in 1987 in his E.F. Hutton and in his PJ & H brokerage
accounts. 1
On December 26, 1989, the district court granted PJ& Hs motion to stay
proceedings pending arbitration and to compel arbitration. Jeppsen v. Piper,
Jaffray & Hopwood, Inc., 879 F. Supp. 1130, 1133 (D. Utah 1995). On December
11, 1991, Jeppsen settled his claims against E.F. Hutton. Around that time, and
after Jeppsen had already paid them $180,000, Jeppsens law firm changed its fee
arrangement to a contingency basis.
On August 31, 1992, the IRS mailed Jeppsen a Notice of Deficiency
regarding Jeppsens 1987 federal income tax. (R. Vol. III Doc. J Exh. 2-B). The
claimed deficiency of $61,297.78 2 resulted from the IRSs disallowance of
Jeppsens $166,627 theft loss deduction. The IRS disallowed the deduction on
the ground that Jeppsen had a reasonable prospect of recovering his loss as of the
Jeppsens theft loss deduction of $166,627 was less than his claimed actual
theft loss of $193,712 because the IRS requires actual theft losses to be reduced
by ten percent of adjusted gross income, plus $100, prior to being deducted. See
1987 IRS Form 4684 (R. Vol. III Doc. 1).
1
The IRS also assessed Jeppsen an addition to tax of $9,735 under I.R.C.
6651, due to Jeppsens delinquency in paying the deficiency of $61,297.78 which
the IRS claimed should have been paid with Jeppsens 1987 tax return. (R. Vol.
III Doc. J
Ex. 2-B).
2
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close of 1987. On November 25, 1992, pursuant to I.R.C. 7442, Jeppsen filed a
petition in the United States Tax Court, challenging the Notice of Deficiency.
On March 17, 1993, before his tax case was tried, Jeppsen filed his
Statement of Claim with the National Association of Securities Dealers, which
was to preside over the compelled arbitration against Piper, Jaffray and Barker &
Larkin. Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F. Supp. 1130, 1133 (D.
Utah 1995). A five-day arbitration hearing was held in November, 1993 in Salt
Lake City, Utah. On January 20, 1994, the arbitration panel awarded Jeppsen
damages of $603,000 (treble damages) plus attorneys fees and costs of
$388,541.55 against PJ & H, Barker, and Larkin, jointly and severally, plus
$250,000 each in punitive damages against Larkin and Barker separately and
individually. This award, however, was subject to appeal to the federal district
court which had ordered the arbitration.
On March 17, 1994, Jeppsens challenge to the IRSs Notice of Deficiency
was tried before the United States Tax Court in Salt Lake City, Utah. At that
proceeding, the tax court was apprised that Jeppsen had won an award from the
arbitration panel, but that the award was not final because the arbitration
defendants still had until April 18, 1994 to appeal the award to the district court. 3
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At the conclusion of the two-hour hearing, the tax court requested further briefing
from the parties and took the case under advisement.
On March 6, 1995, while Jeppsens tax case was still under advisement, the
arbitration panels award in Jeppsens case against PJ & H, Barker, and Larkin
was confirmed by the United States District Court for the District of Utah.
Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F. Supp. 1130, 1140 (D. Utah
1995). The defendants appealed to the Tenth Circuit, but settled the case in June,
1995, before the appeal was heard. Jeppsen v. Commissioner, 70 T.C.M. (CCH)
199, 201, T.C.M. (P-H) 95,342 (1995), T.C. Mem. No. 1995-342; (Aplt.s App.
at 74). The details of the settlement were confidential.
Shortly thereafter, an IRS attorney notified Jeppsen that the tax court had
inquired as to whether a settlement had been reached in Jeppsens case against PJ
& H, Barker, and Larkin, and that the IRS had answered the tax courts inquiry in
the affirmative. In response to these events, Jeppsen filed a Motion To Strike
from the tax court proceedings any information, evidence, or otherwise before
the Court which relates to any result, decision, opinion, or otherwise promulgated
by the United States Court of Appeals for the Tenth Circuit, the United States
District Court for the District of Utah or the National Association of Securities
Dealers, or which relates to any settlement by the parties of any matters pending
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before such entities and related to [Jeppsens case against PJ & H, Barker, and
Larkin]. (Aplt.s App. at 72-73.)
On July 24, 1995, the tax court denied Jeppsens Motion to Strike. In a
brief Order, the court stated that it had requested information regarding the
current status of Jeppsens lawsuits solely for purposes of completeness. It also
noted that the terms of the settlement of the lawsuit . . . were not disclosed to the
Court and that the confidentiality of the settlement was not breached. (Aplt.s
App. at 78.)
Two days later, on July 26, 1995, the tax court issued a Memorandum
Opinion sustaining the IRSs disallowance of the theft loss deduction Jeppsen
claimed for tax year 1987. Jeppsen v. Commissioner, 70 T.C.M. (CCH) 199, 202,
T.C.M. (P-H) 95,342 (1995), T.C. Mem. No. 1995-342. Jeppsen now appeals.
We exercise appellate jurisdiction pursuant to I.R.C. 7482(a).
DISCUSSION
Under the Internal Revenue Code, a taxpayer may deduct from taxable
income any loss sustained during the taxable year and not compensated for by
insurance or otherwise. I.R.C. 165(a). Under Section 165(c), such a loss
includes losses of property not connected with a trade or business or a
transaction entered into for profit, if such losses arise from . . . theft. I.R.C.
165(c)(3). The IRS concedes that Barkers actions constitute theft, and that
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Jeppsens loss therefore qualifies as a theft loss within the meaning of I.R.C.
165. (Appellees Br. at 17). We agree. See Treas. Reg. 1.165-8(d) (defining
theft broadly to include larceny).
At issue here is whether Jeppsens theft loss was sustained during tax
year 1987. Under the Internal Revenue Code, a theft loss is not sustained at the
time the theft actually occurs. Rather, any loss arising from theft shall be treated
as sustained during the taxable year in which the taxpayer discovers such loss.
I.R.C. 165(e). Further, the Treasury Regulations provide that even after a theft
loss is discovered, if a claim for reimbursement exists during the year of the loss
with respect to which there is a reasonable prospect of recovery, then a theft loss
is treated as sustained only when it can be ascertained with reasonable
certainty whether or not such reimbursement [for the loss] will be obtained.
Treas. Reg. 1.165-1(d)(2)(i), 1.165-1(d)(3); accord Treas. Reg. 1.1658(a)(2). In essence, this has been interpreted to mean that the existence of a claim
of reimbursement with a reasonable prospect of recovery will prevent a loss from
being considered as sustained unless and until it is determined with reasonable
certainty that such reimbursement will not be obtained. See, e.g. Rainbow Inn,
Inc. v. Commissioner, 433 F.2d 640, 643-44 (3rd Cir. 1970).
In the present case, based on the evidence before it the tax court found that,
as of December 31, 1987, a viable legal claim for reimbursement existed and
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there was a reasonable prospect that Jeppsen would recover his stolen $194,000.
For this reason, the tax court held that Jeppsen did not sustain a theft loss in
1987.
Jeppsen claims that the tax court erred in two principal respects. First,
Jeppsen claims that the court should not have considered events that transpired
after December 31, 1987, in determining whether Jeppsen had a reasonable
prospect of recovering his stolen $194,000 by the end of 1987. Second and more
fundamentally, Jeppsen claims that the tax court erred in concluding that by the
end of 1987 Jeppsen had a reasonable prospect of recovering his stolen $194,000.
We consider each of Jeppsens claims in turn.
I.
We review Tax Court decisions in the same manner and to the same extent
as decisions of the district courts in civil actions tried without a jury. I.R.C.
7482(a)(1). Thus, we review the Tax Courts factual findings under the clearly
erroneous standard and review its legal conclusions de novo. Anderson v.
Commissioner, 62 F.3d 1266, 1270 (10th Cir. 1995). The question whether a
court may consider events that transpired after the end of a tax year in order to
determine whether, as of the end of that tax year, a taxpayer enjoyed a reasonable
prospect of recovering stolen assets is a question of law which we review de
novo.
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Id. at 402-03.
By rejecting the I.R.S.s exclusive reliance on events which transpired after
1918 as a basis for disallowing the taxpayers 1918 theft loss deduction, the S.S.
White Dental Mfg. Co. court established that a taxpayers ultimate recovery does
not control whether, at the end of a taxable year, that taxpayer enjoyed a
reasonable prospect of recovering property stolen during that taxable year.
However, S.S. White Dental Mfg. Co. did not address the issue of whether the
IRS or a court may consider a taxpayers ultimate recovery as one factor in its
assessment of the reasonableness of the taxpayers ab initio prospect of recovery.
In perhaps the only case from any court to address this distinction directly,
the tax court held that ultimate recovery is irrelevant if it was not reasonably
foreseeable by the end of the pertinent tax year. The court said:
this Court must determine what was a reasonable expectation as of
the close of the taxable year for which the deduction is claimed. The
situation is not be viewed through the eyes of the incorrigible
optimist, and hence, claims for recovery whose potential for success
are remote or nebulous will not demand a postponement of the
deduction. The standard is to be applied by foresight, and hence, we
do not look at facts whose existence and production for use in later
proceedings was not reasonably foreseeable as of the close of the
particular year. Nor does the fact of a future settlement or favorable
judicial action on the claim control our determination, if we find that
as of the close of the particular year, no reasonable prospect of
recovery existed.
Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 811-12 (1974), affd, 521
F.2d 786 (4th Cir. 1975) (internal citations omitted and emphasis added). Accord
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Rainbow Inn, Inc., 433 F.2d at 644 (The test is whether there was a reasonable
prospect of recovery at the time the deduction was claimed, not later.); see also
Dawn v. Commissioner, 675 F.2d 1077, 1078 (9th Cir. 1982) (taking into
consideration a lawsuit filed after the close of the tax year in which a theft loss
deduction was claimed, where it was reasonably foreseeable during the tax year at
issue that a lawsuit would later be filed).
Both parties to the present case agree with the courts statement of the
controlling legal principles in Ramsay Scarlett, although they disagree regarding
the application of those principles to the present facts. We also agree with the
courts observation in Ramsay Scarlett that determination of a reasonable
prospect of recovery is a question of foresight. See also Parmelee Transportation
Co. v. United States, 351 F.2d 619, 628 (Ct. Cl. 1965) (the court must assess if a
reasonable person would have entertained a reasonable chance of recovery during
the year of the discovered loss). Therefore, in accord with the Ramsay Scarlett
decision, we hold that neither the IRS nor the tax court may consider in this
context facts not reasonably foreseeable as of the close of the pertinent tax year.
Nonetheless, we reject Jeppsens claim that in the present case the tax court
improperly considered evidence of Jeppsens ultimate recovery. We agree with
Jeppsen that evidence of a recovery in 1995 should not have influenced the tax
courts ultimate finding regarding the reasonableness, as of December 31, 1987,
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of Jeppsens prospect of recovery. We note, however, that the tax court expressly
stated that its finding was not influenced by its receipt of such evidence. Indeed,
in its July, 24, 1995 Order denying Jeppsens Motion to Strike, the tax court
expressly stated that it had sought information regarding the current status of
Jeppsens lawsuits against PJ & H, Barker, and Larkin, not for any purpose
related to the courts decision making process, but rather solely for purposes of
completeness. In the same Order, the tax court also noted that the terms of the
[final] settlement of the lawsuit . . . were not disclosed to the Court and . . . the
confidentiality of the settlement was not breached. (Aplt.s App. at 78.) Thus,
although the tax court was privy to the details of the arbitration panels award to
Jeppsen, it never learned how much money Jeppsen actually accepted in order to
settle the defendants appeal to this court.
Two days after denying Jeppsens Motion to Strike, the tax court issued its
Memorandum Opinion in the present case. Jeppsen v. Commissioner, 70 T.C.M.
(CCH) 199, T.C.M. (P-H) 95,342 (1995), T.C. Mem. No. 1995-342. In its
FINDINGS OF FACT, the Memorandum Opinion noted: (1) the terms of the
arbitration panels award to Jeppsen; (2) the fact that the award had been
appealed to this court; and (3) the fact that [b]efore the Tenth Circuit rendered a
decision on the appeal, the parties apparently entered into a confidential
settlement of the dispute. Id. at 201. In analyzing Jeppsens substantive claim,
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II.
We now consider the central issue in the case: whether the tax court erred
in its determination that, as of Dec. 31, 1987, Jeppsen had a reasonable prospect
of recovering his stolen $194,000. Pursuant to I.R.C. 7482(a)(1) and Fed. R.
Civ. P. 52(a), we review the tax court's factual findings under the clearly
erroneous standard. Anderson v. Commissioner, 62 F.3d 1266, 1270 (10th Cir.
1995). We review the tax courts legal conclusions de novo. Id.
We review mixed questions of law and fact either under the clearly
erroneous standard or de novo, depending on whether the mixed question is
primarily factual or legal. Id. Where, as here, the sole issue is whether the facts
satisfied the statutory standard, we ordinarily would be inclined to review the Tax
Court's application of the law to the facts de novo. First Nat'l Bank v.
Commissioner, 921 F.2d 1081, 1086 (10th Cir.1990) (tax court findings of
ultimate fact derived from applying legal principles to subsidiary facts are
subject to de novo review).
However, Treas. Reg. 1.165-1(d)(2)(i) provides that [w]hether a
reasonable prospect of recovery exists with respect to a claim for reimbursement
of a loss is a question of fact to be determined upon an examination of all facts
and circumstances. This regulation was promulgated pursuant to the Secretary
of the Treasurys express authority to prescribe all needful rules and regulations
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for the enforcement of the Internal Revenue Code. I.R.C. 7805(a). It appears
to reflect the longstanding maxim that losses claimed under I.R.C. 165 are to be
allowed or disallowed in accordance with practical or realistic considerations. See
Estate of Scofield v. Commissioner, 266 F.2d 154, 160 (6th Cir. 1959) (citing
cases).
This court has long held that a regulation promulgated by an
administrative agency charged with the administration of an Act has the force and
effect of law if it is reasonably related to administrative enforcement and does not
contravene statutory provisions. Joudeh v. United States, 783 F.2d 176, 180-81
(10th Cir. 1986); see also In re LMS Holding Co., 50 F.3d 1526, 1528 (10th Cir.
1995) (holding certain treasury regulations to have the force and effect of law).
With regard to treasury regulations promulgated by the Secretary of the Treasury,
the Supreme Court has specifically held that [b]ecause Congress has delegated . .
. the power to promulgate all needful rules and regulations for the enforcement
of [the Internal Revenue Code], we must defer to [the Secretarys] regulatory
interpretations of the Code so long as they are reasonable. Cottage Sav. Ass'n v.
Commissioner, 499 U.S. 554, 560-61 (1991).
Even more pertinent to the case at bar, the Supreme Court has long held
that [t]reasury regulations and interpretations long continued without substantial
change, applying to unamended or substantially reenacted statutes, are deemed to
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have received congressional approval and have the effect of law. Cottage Sav.
Ass'n, 499 U.S. at 561 (quoting United States v. Correll, 389 U.S. 299, 305-06
(1967) ). We note that Treas. Reg. 1.165-1(d)(2)(i) has not been amended
since 1977, and that I.R.C. 165 (which Treas. Reg. 1.165-1(d)(2)(i) interprets
and implements) was substantially reenacted when the entire Internal Revenue
Code was otherwise revised pursuant to the Tax Reform Act of 1986. We cannot
conclude that Treas. Reg. 1.165-1(d)(2)(i) is an unreasonable interpretation of
I.R.C. 165. We therefore think that Supreme Court precedent requires us to
deem Treas. Reg. 1.165-1(d)(2)(i) to have received congressional approval and
therefore to have the effect of law.
Consequently, we conclude that [w]hether a reasonable prospect of
recovery exists with respect to a claim for reimbursement of a loss is a question
of fact. . . . Treas. Reg. 1.165-1(d)(2)(i). Accordingly, we review the district
courts findings in that regard under the clearly erroneous standard. 5 Ramsay
Scarlett & Co. v. Commissioner, 521 F.2d 786, 788 (4th Cir. 1975) ( tax courts
determination of the reasonable foreseeability of a taxpayers recovery of a loss
reviewable under the clearly erroneous standard).
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In conducting our review, we note that Jeppsen bears the burden of proving
his entitlement to the theft loss deduction. See Interstate Transit Lines v.
Commissioner, 319 U.S. 590, 593 (1943) ([A]n income tax deduction is a matter
of legislative grace and . . . the burden of clearly showing the right to the claimed
deduction is on the taxpayer.). See also Parmelee Trans. Co., 351 F.2d at 628
(observing that taxpayer carries the burden of proving no reasonable prospect of
recovery of the loss). We also note that Jeppsens burden is high: he must prove
that it could have been ascertained with reasonable certainty as of December 31,
1987 that this loss would never be recovered. See Treas. Reg. 1.165-1(d)(3)
([N]o portion of the loss with respect to which reimbursement may be received is
sustained, for purposes of [I.R.C.] section 165, until the taxable year in which it
can be ascertained with reasonable certainty whether or not such reimbursement
will be received.) (emphasis added). Thus, if Jeppsens prospect of recovery was
simply unknowable as of December 31, 1987, then Jeppsen would not be entitled
to take the theft loss deduction in 1987.
A reasonable prospect of recovery exists when the taxpayer has bona fide
claims for recoupment from third parties or otherwise, and when there is a
substantial possibility that such claims will be decided in his favor. Ramsay
Scarlett, 61 T.C. at 811 (citations omitted). Even a small chance of success might
make the pursuit of legal remedies objectively reasonable, especially when the
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stakes are high. A lawsuit might well be justified by a 10% chance [of success].
Parmelee Transp. Co. , 351 F.2d at 628. Accord Rainbow Inn, Inc. , 433 F.2d at
644; Exxon Corp. v. United States, 7 Cl. Ct. 347, 355 (1985), revd on other
grounds, 785 F.2d 277 (Fed. Cir. 1986), vacated after remand, 840 F.2d 916 (Fed.
Cir. 1988), and affd after subsequent remand, 931 F.2d 874 (Fed. Cir. 1991).
The reasonableness of a taxpayers prospect of recovery is primarily
tested objectively, although a court may consider to a limited extent evidence of
the taxpayers subjective contemporaneous assessment of his own prospect of
recovery. Ramsay Scarlett, 521 F.2d at 788 (citing Boehm v. Commissioner, 326
U.S. 287, 292-93 (1945)). As the Boehm Court explained, [t]he taxpayers
attitude and conduct are not to be ignored, but to codify them as the decisive
factor in every case is to surround the clear language of . . . [the applicable
statute] with an atmosphere of unreality and to impose grave obstacles to efficient
tax administration. 6 Boehm, 326 U.S. at 293.
Under Treas. Reg. 1.165-1(d)(2)(i), a taxpayers prospects of recovery
may be ascertained with reasonable certainty, for example, by a settlement of the
claim, by an adjudication of the claim, or by an abandonment of the claim.
Boehm did not involve the theft loss deduction at issue here, but rather a
deduction available to holders of corporate stock that becomes worthless.
However, the Fourth Circuit in Ramsay Scarlett analogized to Boehm in a very
similar context, and we agree that the analogy is apt.
6
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Courts have occasionally suggested that the fact that a taxpayer files a lawsuit
may give rise to an inference that the taxpayer has a reasonable probability of
recovering his loss. See Dawn v. Commissioner, 675 F.2d 1077, 1078 (9th Cir.
1982) (applying such an inference); Estate of Scofield v. Commissioner, 266 F.2d
154, 159 (6th Cir. 1959) (filing lawsuit may give rise to inference of reasonable
probability of recovery unless the lawsuit appears to have been specious,
speculative, or wholly without merit); Parmelee Transp. Co., 351 F.2d at 629
([A] suit by a taxpayer will not operate as a presumption; at the most it leads to
an inference which leads to an evaluation of the probabilities.). Several courts
drawing an inference of reasonable prospect of recovery from the fact that the
taxpayer has filed a lawsuit have been willing to consider lawsuits filed after the
end of the tax year for which the theft loss deduction was claimed, so long as the
taxpayer contemplated filing the lawsuit during that tax year. See Ramsay
Scarlett, 61 T.C. at 812 (noting that taxpayers retaining a lawyer and generally
acting as though gearing up for a contest to vindicate legal rights during the
year of the discovered loss may be evidence of reasonable certainty of recovery
even though suit not formally filed until following tax year). See also Dawn, 675
F.2d at 1078-79 (citing cases).
We agree that the fact that a taxpayer, in a given tax year, contemplates
filing a suit to recover his losses may be considered in the mix of evaluating
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whether the taxpayer has a reasonable prospect of recovery. However, like any
other subjective factor, this inference should not control the outcome of the case.
See Boehm, 326 U.S. at 292-93. As noted earlier, the primary analysis of whether
there is a reasonable prospect of recovery on a claim for reimbursement of loss is
an objective one.
With these principles in mind, we review the tax courts determination in
the present case. In support of its position that Jeppsen was not entitled to a
theft loss deduction in tax year 1987 for the losses he suffered that year at the
hands of stockbroker Barker, the tax court found that, by the end of 1987: (1)
Barker had engaged in conduct that was both illegal and actionable; (2) Jeppsen
knew what Barker had done; (3) Jeppsen began shopping for lawyers immediately
and never at any time ceased attempting to recover his money; (4) Barkers
former employers PJ & H and E.F. Hutton were proper co-defendants, both of
whom had more than sufficient assets available to satisfy any judgment awards
against them; and (5) Jeppsen filed suit in March, 1988, several months before
he filed his 1987 tax return.
As Jeppsen points out, several countervailing facts indicate that Jeppsens
prospects of recovery were never, until he prevailed, 100 percent. In particular,
Jeppsen notes that: (1) both PJ & H and E.F. Hutton consistently disclaimed any
liability; (2) no lawyer contacted by Jeppsen would take his case on a contingency
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may be received is sustained, for purposes of section 165, until the taxable year in
which it can be ascertained with reasonable certainty whether or not such
reimbursement will be received. Thus, the taxpayer need only prove that it is
reasonably certain that reimbursement will not be received; there is no
requirement of proof that the loss will never be recovered. See United States v.
S.S. White Dental Mfg. Co., 274 U.S. 398, 402-03 (1927) (a loss may become
complete enough for deduction without the taxpayers establishing that there is no
possibility of eventual recoupment).
B.
Whether a reasonable prospect of recovery exists with respect to a claim
for reimbursement of a loss is a question of fact to be determined upon an
examination of all facts and circumstances. Treas. Reg. 1.165-1(d)(2)(i). The
Tax Courts finding in this case is reviewed under the clearly erroneous
standard; [a] finding is clearly erroneous when although there is evidence to
support it, the reviewing court on the entire evidence is left with the definite and
firm conviction that a mistake has been committed. United States v. United
States Gypsum Co., 333 U.S. 364, 395 (1948). I am convinced that a mistake
was committed when the Tax Court rejected the taxpayers substantial and
uncontroverted proof that, at the end of 1987, he lacked a reasonable prospect of
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later recovering his loss. See Rainbow Inn, Inc. v. Commissioner, 433 F.2d 640,
644 (3d Cir. 1970) (reversing Tax Courts determination that a reasonable
prospect of recovery existed).
Several well-established principles guide review. In determining whether a
reasonable prospect of recovery exists, the relevant facts and circumstances are
those that are known or reasonably could been known as of the end of the tax year
for which the loss deduction is claimed. See Halliburton Co. v. Commissioner,
946 F.2d 395, 400 (5th Cir. 1991). The only fair test is foresight, not hindsight.
Scofields Estate v. Commissioner, 266 F.2d 154, 163 (6th Cir. 1959) (Tax
Courts findings were clearly erroneous because factual conclusions and
inferences drawn from the facts were based upon hindsight). Both objective and
subjective factors may be examined. Boehm v. Commissioner, 326 U.S. 287, 292
(1945); Ramsay Scarlett & Co. v. Commissioner, 521 F.2d 786, 788 (4th Cir.
1975).
One of the facts and circumstances deserving of consideration is the
probability of success on the merits of any claim brought by the taxpayer. While
it is true that the filing of a lawsuit may give rise to an inference of a reasonable
prospect of recovery, Dawn v. Commissioner, 675 F.2d 1077, 1078 (9th Cir.
1982), the inference is not conclusive nor mandatory. Merely because a lawsuit
with a ten percent chance of recovery might be justified on grounds of principle
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does not mean that the lawsuit provides a reasonable prospect of recovery.
The inquiry should be directed to the probability of recovery as opposed to the
mere possibility. Parmelee Transp. Co. v. United States, 351 F.2d 619, 628 (Ct.
Cl. 1965). A remote possibility of recovery is not enough; there must be a
reasonable prospect of recovery at the time the deduction was claimed, not later.
Rainbow Inn, 433 F.2d at 644.
Surely a reasonable prospect of recovery encompasses an assessment of
litigation risk at the time the deduction is claimed; given the uncertainty of trial
and proof, there is a world of difference between pleading a claim, proving it and
bringing it to judgment. Moreover, the obvious defenses to a claim cannot be
ignored, nor can the financial capacity of a defendant to vigorously contest
liability. At the Tax Court trial, the only testimony about the mechanics of the
taxpayers claim and the defenses raised was the attorney who prosecuted the
claim, an expert in the field of securities litigation. No persuasive reason exists
for disregarding his testimony. See Ramsay Scarlett, 521 F.2d at 789 (Widener,
J., concurring) (The opinion of Sykes, admittedly a skillfull attorney, as to the
merits of the taxpayers claims against the bank, was obviously relevant in any
kind of objective inquiry.). Although the government, with 20-20 hindsight,
suggests various theories of liability that should have been apparent in 1987, most
of the telling facts were developed later and the difficulty of successful proof on
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controverted facts makes the outcome far less apparent. See, e.g., Hotmar v.
Lowell H. Listrom & Co., 808 F.2d 1384, 1385 (10th Cir. 1987) (directed verdict
in favor of defendants on churning claim).
Here, despite the taxpayers belief that he had been wronged, virtually no
evidence existed to substantiate the taxpayers claims as of December 31, 1987.
From a procedural perspective, the taxpayer had signed an account agreement
with PJ & H that contained an arbitration clause that would limit discovery, so it
was necessary to mount an attack on the validity of the arbitration clause in
federal court (an attack that would ultimately prove unsuccessful), in part to
obtain the liberal discovery allowed by the federal rules. The scope of discovery
that was ultimately allowed in federal court greatly benefitted the taxpayer, but
that scope was fortuitous.
The merits of the case depended not only upon credibility, but also a
determination of whether PJ & H could be responsible for the activities of its
broker. PJ & H denied liability and responsibility for its broker, despite an
admission by the branch manager that the unauthorized discretionary trading was
improper. The parties have stipulated that the brokers actions constituted theft
under Utah law, and only if taxpayer could prove that the brokers conduct was in
the course and scope of his employment would there be vicarious liability based
upon respondeat superior. See Jackson v. Righter, 891 P.2d 1387, 1391 (Utah
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1995); Birkner v. Salt Lake County, 771 P.2d 1053, 1056-59 (Utah 1989).
Several courts have held that employee theft is not within the course and scope of
employment, see, e.g., Los Ranchitos v. Tierra Grande, Inc., 861 P.2d 263, 268
(N.M. App. 1993); B.B. Walker Co. v. Burns Intl Security Servs., 424 S.E.2d
172, 174 (N.C. App.), review denied, 429 S.E. 2d 552 (N.C. 1993); but see
Richards v. Attorneys Title Guaranty Fund, Inc., 866 F.2d 1570, 1572-73 (10th
Cir.) (applying Restatement (Second) of Agency 261 (1958); vicarious liability
for agents theft), cert. denied, 491 U.S. 906 (1989), and the Utah courts have
recognized that the issue may be decided as a matter of law when the employees
conduct is so clearly outside the scope of employment that reasonable minds
could not differ, see Jackson, 891 P.2d at 1391; Birkner, 771 P.2d at 1057. Given
the parties stipulation of theft, the taxpayer had a formidable legal barrier to
overcome.
As of December 1987, PJ & H also could be expected to defend on the
basis that (1) the taxpayer was a sophisticated, aggressive investor who authorized
the transactions and sought return without regard for risk, (2) the taxpayer had
received confirmations and account statements and therefore had ratified the
transactions, and (3) the taxpayer was merely trying to avoid the consequences of
the 1987 market fall. I am persuaded that all of these objective factors viewed as
of December 1987, together with the taxpayers statement on cross-examination
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that he pursued the matter as a moral issue, despite advice that his chances were
not very good, Aplt. App. at 155, render the Tax Courts finding clearly
erroneous.
I would reverse and therefore respectfully dissent.
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